Expanding Your Franchise Internationally

Structure of the International Transaction

Once you've identified qualified candidates, remember: The strength of your partner is even more integral to your success internationally than it is domestically. As a franchisor, you may have significant difficulties that you would not encounter domestically. And you will be dealing with a franchisee that has substantially greater responsibilities than your typical domestic franchisee. Not only will your franchisee be responsible for developing and adapting your foreign prototype, but he or she will also be responsible for implementing your expansion plan for an entire country.

Once you've identified the best possible international franchise candidate, the next question you must deal with is the structure of the transaction. One of the first questions that any company new to international franchising will face involves whether to expand by direct franchising, joint venturing or master licensing.

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In direct franchising, the franchisor organization sells franchises and attempts to directly support those franchises in the market. In essence, the U.S. franchisor would attempt to directly duplicate its domestic success in the foreign market.

This form of entering any foreign market is probably the most difficult, unless the market in question is in close physical proximity and is relatively similar from an economic and social perspective. While some U.S. franchisors favor this method of expansion in Canada and Mexico, it's extremely cumbersome when it comes to more distant foreign markets.

From a definitional perspective, a franchisor could be said to be entering a foreign market through the use of a joint venture if that franchisor maintained an equity interest in the company that was established to expand the concept in that market. This strategy has the advantage of allowing the franchisor to participate in the equity appreciation of the foreign entity while providing it with an ongoing revenue stream, generally based on gross sales.

Given the increased risk and capital demands of this strategy, however, it's estimated that fewer than 12 percent of U.S. franchisors opt for variations of this structure. Typically, only the largest and best-capitalized franchisors can afford a long-term investment of this nature.

By far, the most popular method of entering new international markets is through the use of a countrywide master franchise or area developer. Typically called a master licensee, this company (these are generally not sold to individuals) will be much more sophisticated and better capitalized than the average individual franchisee.

As a starting point, you're probably looking at selling the entire country, or at least a substantial territory within a larger country. While some of these arrangements are structured like area development agreements, most resemble subfranchise arrangements, in which the partner would not only develop units, but will sell franchises much the same as you would as a franchisor. Franchisors typically are compensated in these arrangements through a combination of initial territory fees, a percentage of ongoing fees and a percentage of individual franchise fees.

Fee Structure
Before deciding on a fee structure, it's important to get an understanding of the services required to establish a successful international venture. Fees can then be determined only after estimating associated expenses. Bear in mind that the costs of closing an international transaction can be significantly higher than a domestic transaction. Brokerage fees, international franchise attorneys, travel costs and substantial training commitments both at home and abroad can easily give you a six-figure headache.

For this reason, initial fees for most countries generally range between $100,000 and $1 million, depending on the size and maturity of the market involved and the overall demand for the franchise in question.

Similar to domestic transactions, most franchisors look to their international franchise fees primarily as a cost recovery tool and only secondarily as a profit center. The franchisor would, obviously, like to maximize franchise fee revenue. However, knowing the importance of establishing the channel (and its associated royalties and/or product sales), most franchisors price their fees low enough to avoid erecting substantial barriers to the franchise sale.

Unlike domestic transactions, in which a fee is generally specified in advance for inclusion in the Uniform Franchise Offering Circular and isn't subject to negotiation, international franchise fees are often subject to negotiation based on what each party is "bringing to the table." (Note: U.S. franchisors aren't required to comply with U.S. disclosure laws for foreign transactions, but may be subject to foreign disclosure laws.) Moreover, since the costs incurred in a transaction might vary substantially, there's often an economically justifiable reason to raise or lower fees.

In a master franchise relationship, both royalties and franchise fees are generally a fraction of what they are in a direct franchise relationship, with the licensee generally receiving the lion's share of the revenues from both. The U.S. franchisor generally receives between 20 percent and 50 percent of the franchise fee upon each unit opening, and between 25 percent and 40 percent of royalty revenues. These fees should not be determined based on the country in question, but rather on detailed financial analysis and an understanding of specific support services required.

In structuring these transactions, two additional points are of critical importance: performance requirements and expenses. The speed with which you're able to establish the foreign franchise organization will be a critical element in determining when you'll achieve positive cash flow. If your licensee isn't willing or able to commit to an aggressive development schedule, be sure that you write provisions into your agreement requiring them to cover all direct expenses until a certain number of franchises have been established.

Lastly, be sure that you or your U.S. franchise attorney retains an attorney familiar with franchising in the host country prior to finalizing any agreement. Peculiarities relative to allowable royalties, intellectual property, trademark, employment and anti-trust laws may have a profound impact on your structure.

The Decision to Go Abroad
International franchising isn't a venture to be entered into lightly. Aside from complex international legal and regulatory environments, the prospective international franchisor must be prepared to make a substantial commitment of time and resources to its international business. And to be successful, the franchisor must be highly selective--working only with the right partner and choosing only counties in which the concept will be well received.

Not all franchisors are ready for this level of commitment. But for those that are, the "export opportunities" can be quite rewarding.

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